Game Group gains after recent fall on new release hopes

Followers of Game Group often worry about whether the recent growth in the computer games market can be sustained, and longer term, how the company will react to the nascent competition from downloads and online products.

Trade figures out this week from the US showed weaker than expected software sales in September and gave some fuel to bears of the company. Shares in both Game and also its American rival Gamestop have fallen sharply since the release of the data a couple of days ago. (Gamestop, by the by, is often tipped as a potential purchaser for the UK retailer).

Today however Game has recovered some of its losses, rising 3.1p to 153p as analysts suggest the US figures might not be as bad for the company as first feared. Altium, for example, issued a buy note on the business and said:

Game's shares have fallen around 5% in the past couple of days reacting, it would appear, to two related stimuli. First was the release of NPD sales data for the US which showed disappointing growth in software. Presumably as a result of those data, Gamestop, the world's largest video games retailer, saw its shares fall sharply. However, the NPD release also noted strengthening sales of consoles following the recent price reductions.

Ultimately, this will lead to increased software sales. It remains the case that pre-orders indicate that the soon-to-be-released Call of Duty: Modern warfare II will be the largest title launch ever.

We believe that the long-term future for games will be dominated by games that are either downloaded or hosted in 'the cloud'. This is not good news for store-based retailers. However, we believe that it will be several years before we reach that point. Game's average store lease-length is around 6 years. This should afford it the flexibility to react to a shrinking high street market. Its balance sheet would seem to allow it the potential to either develop organically or acquire a position in the download/hosting market.

None of this argues for even a sector average rating. Our target price [of 190p] would give a PE of 8.3 times, a discount of around 40% to our sector coverage. However, a PE of only 6.6 times suggests to us that the shares have been over-sold. Even after its fall, Gamestop trades on a forward PE of over 9 times.

Freddie George at Seymour Pierce was also positive, saying:

The recent selling in Game has been overdone based on trade figures for September coming out from the US. However, one should take into account that the US market has not benefited from FIFA 10 or Pro Evolution Sport, which comes out today. In addition, the US retailer, Gamestop will not benefit to the same extent from capacity coming out of the market, in particular Zavvi and Woolworths.

But, as it takes two to make a market, there are also some sellers out there. Matthew McEachran at Singer Capital Markets is one. He said today:

NPD's September data showed that the US games industry essentially stayed pretty flat, with revenues rising by just 1% compared to September 2008 despite the boost expected to have come from price cuts in all three major consoles. Software was the driver of this marginal increase, helped in particular by Halo 3.

This may back up our view that the price cuts, especially in relation to Sony's PS3, have been insufficient thus far to trigger the meaningful uplift in selling volumes that have generally been hoped for, albeit things could yet change in the run up to Xmas. The next update will be an interim management statement in December. As stated in recent research notes, we continue to adopt a cautious stance towards earnings forecasts, for both the current year (January 2010) and next year (January 2011), despite the downgrades factored in to date.